In this article, Dave Lewis, CEO and founder at Ranqx explains some of the challenges associated with existing small to medium sized business (SMB) credit underwriting models, as well as the problems that these flaws can have on everyday businesses. Dave goes on to explain how innovative new underwriting solutions, which leverage more data, can help the sector to evolve.

Credit underwriting may not jump out as the world’s most exciting subject, but scratch beneath the surface and you’ll quickly realise how important it is. Simply put, lending capital is the bedrock of many modern economies, but it’s becoming harder for businesses to attain. In my opinion, it’s an area that’s been overlooked within the world of finance. In fact, while other financial services have evolved with the times, many of the systems used to formulate SMB credit decisions have remained largely the same for decades.

A BROKEN SYSTEM THAT NEEDS FIXING

We’re likely all familiar with the phrase, ‘don’t fix something that isn’t broken’, sadly, that famous adage doesn’t apply here. Existing credit underwriting solutions are not fit for purpose, relying on historical and decaying end of year tax accounts and historical credit reports and are costing SMBs considerably each year. Now, as we emerge into a post-COVID landscape, these businesses need all the support they can get to remain viable. To do this, credit underwriting measures need to be updated, with more relevant and up to date data leveraged into the decision-making process.

Right now, traditional credit underwriting measures rely on limited and aged data sets when deciding on the true viability of a business. However, the changing nature of many businesses, as well as some of the broader societal changes in the world have rendered these models largely obsolete. At the same time, the case to utilise alternative forms of data within credit underwriting has become too great to ignore. As such, now may be the time for this evolution to be embraced, particularly as pressures grow on SMBs.

TIME TO ALLEVIATE PRESSURES

Despite making up around 90% of all global companies, and employing over half of the world’s collective workforce, SMBs receive significantly less lending support from financial institutions than their larger counterparts. In fact, the World Bank estimates that the world’s micro, small and medium-size enterprises need an additional $5.2 trillion to reach existing unmet finance needs [1]. Unfortunately, this number is roughly 1.5 times the current lending market for such businesses, which poses a difficult challenge [2].

What’s more, despite a desperate need to increase lending to SMBs, bank approval percentages are around half what they were two years ago [3]. Clearly, the pandemic has shaken the confidence of lenders to engage with businesses in the ways they had previously. On one hand, this downturn should be expected against a backdrop of economic uncertainty, but it’s a situation that requires intervention. Moving forward, new measures must be implemented that can provide these institutions with more confidence.

THE PROBLEM AT PLAY

It stands to reason, but business insolvencies dramatically increase in situations when short-term financing cannot be obtained. Without access to lending capital, SMBs only have limited options in how to respond. Sadly, this normally involves companies having to cut costs, normally through staff layoffs, or postponing expansion plans. Neither option is conducive to a fully prosperous economy. As we begin to assess potential routes out of a global economic downturn, it will be essential to fix this issue.

Protecting SMBs is something that the global community needs to prioritise for several reasons. For one, two out of three new private sector jobs are currently created by SMBs [4]. What’s more, money spent with SMBs is far more likely to recirculate around local communities, and on average, these companies contribute a greater proportion of their earnings in taxes [5]. Evidently, there are clear societal and economic benefits generated when SMBs thrive, which makes the case to support them even greater.

FINDING A SOLUTION

As established, the need to accelerate the flow of capital to SMBs is pressing, with the advantages of such a move beneficial to businesses and societies across the world. With better access to funding, SMBs could help to create an economy with higher levels of sustained employment and rises in productivity. All in all, the shift could contribute to a more efficient economic environment, which is needed more than ever within the context of a post-Covid world that faces growing recessionary pressures.

To put into context, recent research from Deloitte shows ‘not one traditional US bank has the online capabilities to provide a straight-through small business loan application for either unsecured or secured loans with an instant decision or offer to the customer’ [6]. This can no longer be considered a satisfactory situation and must change. Therefore, the question is how we can go about solving the issue.

Thankfully, there are new solutions that make the underwriting process easier than ever before, removing friction for both the SMB applicant and the lender by seamlessly leveraging a world of SMB data points in accounting, banking, credit, and registry data sets. However, to truly deliver value, these services must be onboarded by banks, credit unions and other non-financial lenders as quickly as possible. This will require a sector, which has previously been criticised for its unwillingness to embrace new technologies, to adapt at pace. Thankfully, the early evidence is that there’s ample demand for the shift.

We are entering a new era of trends and opportunities within the field of SMB lending. The economic impact of the Covid-19 pandemic was vast, and has severely affected the credit lending market, especially for SMBs. However, as nations around the world look to rebuild, these businesses will be required to play a vital role and therefore need support. The good news is by embracing tech first solutions, credit unions can provide this to them more efficiently and effectively than ever before.

SOURCES:

1. https://documents1.worldbank.org/curated/en/729451600968236270/pdf/Small-and-Medium-Enterprises-in-the-Pandemic-Impact-Responses-and-the-Role-of-Development-Finance.pdf
2. https://documents1.worldbank.org/curated/en/729451600968236270/pdf/Small-and-Medium-Enterprises-in-the-Pandemic-Impact-Responses-and-the-Role-of-Development-Finance.pdf
3. https://www.theguardian.com/business/2020/dec/14/us-small-businesses-traditional-bank-loans-dry-up
4. https://www.washingtonpost.com/business/on-small-business/who-actually-creates-jobs-start-ups-small-businesses-or-big-corporations/2013/04/24/d373ef08-ac2b-11e2-a8b9-2a63d75b5459_story.html
5. https://www.choosedupage.com/why-is-spending-at-a-local-business-better-for-your-community/
6. https://www2.deloitte.com/us/en/insights/economy/americas/latin-america-economic-outlook.html